NIRP-ZIRP-PIRP Won’t Put All of Tech20 into a Spin

In a long, strong‐dollar cycle and a rising US rate environment that looks less like a sure thing, treasurers must be adept at finding speed in headwinds as well as tailwinds, and they should catch the breeze opportunistically.  

In shifting conditions created by negative interest-rate policy (NIRP) in Europe, moves toward zero interest-rate policy (ZIRP) in other parts of the world and the US seeking to return to a positive interest rates policy (PIRP), Tech20 treasurers are trying to keep moving forward without being forced into an unwanted spin. Highlights from their midyear meeting included:

1) FX Outlook and Hedging Strategies for a Long, Strong-Dollar Cycle: The strong-dollar cycle will resume, after recent wobbles, as US GDP growth picks up in the second half. This will restart the Fed rate-hike watch as well.

2) Spin-off Lessons for Tech Firms: The urgency of timelines requires decisive actions that don’t wait for democratic consensus and that don’t let optimization get too much in the way.

3) Liquidity Management Consequences of an Upside-Down World: Negative interest rates in Europe have created an environment where deposit locations have to be carefully chosen and investors seeking positive returns have to go out into long-term assets or be willing to invest in less-familiar asset classes.

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FX Outlook and Hedging Strategies for a Long, Strong-Dollar Cycle

Bank of America Merrill Lynch Senior G10 FX Strategist John Shin walked the group through an overview of his and the bank’s view on the US dollar and its position in the global economy. And Head of Strategic Risk Management Solutions Hector Lugo offered the group some points to consider with their FX management strategies.

Key Takeaways

1) The US economy is expected to rebound along with the strong-dollar cycle. The outlook from Mr. Shin pointed to the likelihood, consistent with the pre-meeting survey, that the strong-dollar cycle will resume, as US GDP growth picks up in the second half. This will restart the Fed rate hike watch as well.

2) Have a metric that speaks to how well your FX program is working. Mr. Lugo highlighted six recent trends in MNC FX management: (1) more hedging of earnings translation risk; (2) increasing the hedge ratio and extending the hedge tenor; (3) hedging net investment in foreign operations (especially in anticipation of a dividend); (4) quantifying risk on a portfolio basis instead of using notionals (e.g., value at risk, cash flow at risk or earnings at risk); (5) more systematic vs. opportunistic hedging and (6) more hedging of emerging market currencies. The key to success with any of these trends is for treasury to communicate clearly what the metric is that shows the program to be working. This can be VaR with and without hedging or the volatility of results with or without hedging, he noted. Too many programs are also judged as failing because they take into account the performance of the hedges and not that of the underlyings. Your CFO has to take into account both and buy into the measure of success put forward by treasury.

3) Sync your program with constant currency reporting methodology. BAML noted that few corporates are consistent or thoughtful on the rates they use in non-GAAP reporting of constant currency results. Thinking about the rate used and how it syncs with your FX management approach can dramatically help your FX impact and mitigation narrative. For companies whose risk-management objective is to minimize year‐over‐year volatility due to changes in FX rates in their financial results, for example, it is important to understand how year‐over‐year changes are calculated. If they are calculated using hedge rates of the current period vs. unhedged rates of the prior period (aka an accounting method), then a 12‐month rolling hedging strategy can be seen as more effective. If the method is to compare hedge rates of the current period with hedge rates of the prior period (economic), then a multi‐year layered hedging strategy can be seen as more effective.

Outlook

A long, strong-dollar cycle, just like a long, weak-dollar cycle can tempt treasury to adopt opportunistic hedging or otherwise alter their program to their currency view. This cuts against the grain of the market valuing consistency and the difficulty in justifying hedging high-carry, emerging market currencies without any consistency. It may also explain why very few members indicated that their FX program was tuned for a strong USD. Going forward the goal is simple: Be consistent and clear about the hedge objective (its measure of success) and pursue that objective consistently.

Spin Lessons for Tech Firms

Two group members shared what they have learned pre-spin in preparation for their corporate separation plans. Another group member shared final post-spin lessons.

Key Takeaways

1) Leverage transformational project teams for the transaction. One member noted that they reassigned a transformational project team that was starting work on an effort to create an optimal treasury and shared-service platform to the separation project. While the transformational project was put aside for the company separation, having a team attuned to optimization tackling the creation of two treasury and shared-services platforms for the post-split companies heightened the chances that some progress will be made pre-split, or at least the structures created will be better able to accommodate anticipated changes post-split.

2) Spins are no time for idealism. Despite hopes to optimize to the furthest extent, two main takeaways from our panel of members was that the urgency of their timelines requires decisive actions that don’t wait for democratic consensus and that don’t let optimization get too much in the way. All of the member panelists urged the creation of an empowered separation committee with a strong chairman/leader, but also clearly delegated authority to prevent too much escalation, in order to keep the project moving. They also endorsed the mantra: “Separate quickly, optimize later.”

3) Governance aimed at a close date gets things done. Similar to the top-down mandate to focus on separation actions vs. thinking about what might be best, the governance structure put in place for a separation, including PMO outsourcing and the use of any consultants required, point out how much can get done if it really has to. Taking advantage of this mindset to boost the growth potential of the company post separation is something to keep in mind. Indeed, boosting the “can-do” attitude of governance should be considered at the top when reshaping and upgrading the board in preparation for splitting it on down to each level of management.

4) Keep in mind that the transformational event may not involve a transaction. One member recalled how a total restructuring that came with the company’s close encounter with the grim reaper created a unique opportunity for treasury to an optimization that proved life-changing when the company recovered and helped it support rapid growth more efficiently.

5) Communicate with an eye to avoiding misunderstandings. Another one of the clear takeaways from these discussions of spin-offs was the importance of communication. Too much valuable time gets lost, even if there is a well-thought-out framework of working groups and steering committees to execute the transaction, when people think they are on the same page regarding what should be getting done, but are really not. “You want to communicate both clearly and in a timely fashion in order to avoid the rumor mills from mushrooming,” as one member noted. You also want to focus on your staff and give them their transition and future job descriptions as early as you can: you will need them.

6) Separation date provides ultimate cash definition. One of the lessons learned in the post spin-off example was the importance of thinking about cash for splitting it on the actual separation date. Payables, intercompany transactions and other items complicate the definition of available cash to split. You need to have a methodology to define cash.

Outlook

Since one of the key lessons is to start early — especially in treasury because it has so much more to do than other functions (like create two different capital structures) — it might make sense to plan a bit before a transaction is known. There can be signs that the strategic plan involving synergies with distinct lines of business is not paying off. Taking the work and tight timelines of a separation to heart, treasury should consider having a contingency plan or two on the shelf for when a transaction or other transformational event creates or forces a change opportunity. It can also help to have clear documentation of roles, responsibilities and processes.

Liquidity Management Consequences of an Upside-Down World

BAML’s François Antoine, EMEA Investment Solutions Officer, walked the group through how negative interest-rate policy, or NIRP, is changing the nature of cash investments — not only in Europe, but globally.

Key Takeaways

1) European interpretation of the Basel III rules is being adopted on different timelines. The European interpretation of Basel III regulations is being implemented at various speeds: The Netherlands is well ahead on implementation, whereas Italy and Spain have barely started. Thus, different products and structures, including cash pools, will lead and lag across Europe. Not all banks have sought to future-proof their products based on eventual adoption.

This creates liquidity management challenges but also opportunities. For example, the opportunities start with lowly deposits: for instance, you might see (but not for long; see Basel III adoption point above) time deposits in places like Denmark, where you may have to pay -20bps, whereas in Spain you could see +80bps — it is all about risk/reward with location and the bank, says BAML’s Mr. Antoine.

2) NIRP is making yield-seeking on cash investments hypercompetitive. Negative interest rates in Europe have created an environment where investors seeking positive returns have to go out into long-term assets or be willing to invest in less familiar asset classes. Moreover, everyone with excess cash is under pressure to do this, because to pay for liquidity you don’t need is different from just incurring opportunity cost on basis points you have not earned. This ups the ante on the need for members to have flexible enough policies and delegation of authority to act decisively, albeit well-informed about the risks, when positive return opportunities for cash investment present themselves. But they extend from there to repo solutions, to commercial paper, to corporate bonds, to supply-chain finance with master trust structures and to dual currency placements, just to cite the examples discussed.

Outlook

The situation in Europe reminds us just how out of kilter the financial world is, tilted upside down, even, by NIRP. That the banking system and its customers have to cope with this, at the same time that bank regulations, as interpreted by the various country jurisdictions, are coming on-line, makes for difficult sailing. What remains is the need to improve cash forecasting in order to gain confidence in its accuracy and more time to act with this better information. There are countless actions that treasurers can take with better information about their future cash-flows, from telegraphing deposits coming to banks, putting those deposits where they will earn the best return or having enough confidence to push the flow of funds into less-liquid assets. What’s changed is the need for action. Whereas in a normal rate environment the costs of poor cash management are largely opportunity costs, in a NIRP-tilted world the costs register clearly. Accordingly, treasurers are no longer sheltered by the mindset that they are not adequately rewarded for earning extra basis points on cash invested, but always penalized for losing on perceived risk-taking. NIRP encourages risk-taking, so now you are losing from the start.